Tim Duy's Fed Watch:
The next FOMC meeting is just a week out, and market participants still lack a firm consensus on the path Greenspan & Co. will choose, but, as reported by David Altig, the tide has turned in favor of those who see another rate hike in the near future. In a similar vein, this quote from Saturday’s Washington Post likely summarizes the Fed’s thinking at this point:
If Federal Reserve policymakers had to vote
today, they'd probably raise short-term interest rates a notch out of
concern that Hurricane Katrina could harm the U.S. economy more by
boosting inflation than by slowing growth.
have to agree. Recent Fedspeak and data give little reason to believe
that the FOMC is ready to change course, despite Katrina. While not
discounting the real suffering of those affected by this disaster, Fed
officials appear to be more worried about inflationary pressures rather
than weak demand.
The much awaited speech by Chicago Fed President Michael Moskow was decidedly hawkish (see Mark Thoma here).
Perhaps more interesting was San Francisco Fed President Yellen’s
speech, which was widely viewed as less hawkish than Moskow (see
William Polley here).
I tend to agree; Yellen appeared more cautious than her Chicago
colleague. But some little noted commentary places Yellen in a
different light (I can’t take credit for spotting this; it was passed
on to me by a contact). Take a look at Yellen’s previous speech on July 29. On that day Yellen thought:
A final factor impacting the inflation outlook is the degree of slack
in the labor market. Right now, the unemployment rate is relatively
low: at 5 percent it’s near most estimates of the so-called natural
rate. But other measures—such as the employment-population ratio, a
survey of job market perceptions, and industrial capacity
utilization—suggest that some slack still remains.
Just a few weeks later, AFTER Hurricane Katrina, Yellen has a different view:
we assess the likely behavior of wage pressures going forward, we must
also factor in the influence of slack in labor and product markets. The
decline in the unemployment rate to 4.9 percent in August, coupled with
some improvement in measures such as the employment-population ratio
and industrial capacity utilization, suggest that while a "whisker" of
slack may still remain, we probably can't count on slack to hold
Placing these paragraphs side by
side, it appears that Yellen has reassessed the degree of slack
remaining in the economy – and her conclusion is undeniably more
hawkish. Likewise, from July 29:
Looking at the big
picture elements—growth, employment, and inflation—I’d say things are
in reasonably good shape. Over the past two years, the nation’s output
growth has been pretty steady, averaging just over four percent; this
is solidly above trend, which, by most estimates, is around three and a
quarter to three and a half percent.
on the real side of the economy, the nation's output growth has
averaged about three and one-half percent over the past year, a rate
that is moderately above trend, which is now probably around three to
three and a quarter percent.
Yellen appears to have
settled on the lower estimate of potential growth, possibly a result of
slowing productivity growth. Indeed, just a day earlier, we were greeted with news
that second quarter productivity was revised downward and labor costs
revised upward. This shift in Yellen’s language is subtle but
important as it again suggests Yellen sees less slack in the economy
compared to just a few weeks ago. So, in a nutshell, while Yellen may
appear less hawkish than Moskow, she appears more hawkish than before
Katrina, suggesting an increased willingness to stick with the current
policy of “measured increases.”
Monday we also heard from Dallas Fed President Richard Fisher
in something of a surprise speech. Everyone needs to take a look at
this speech. I expect many different opinions. Simply put, Fisher is
shaping up to be the most enigmatic Fed official in recent memory.
Recall that Fisher first broke onto the scene with his famous
proclamation that the Fed is in it “eighth inning” as far as rate hikes
are concerned. It soon became clear that the remainder of the FOMC did
not share this view. Now, according to Bloomberg:
Dallas Fed said as recently as Friday that Fisher would not be making
any public appearances this week. Bank spokesman James Hoard said the
speech was given at 1:30 p.m. local time in Austin, Texas, at a private
event that wasn't open to the public or reporters.
out Fisher spoke quite a bit about the economy, and it became necessary
to post his speech on the Dallas Fed website. He sounds like he is
ready to pause:
When it comes to Katrina and the U.S.
economy, my inclination is to read, listen and watch and not rush to
judgment about how the disaster will impact the economy or how monetary
policy ought to respond.
This caution, however, does not stop him from listing a litany of reasons to expect little economic impact:
might recall that a powerful earthquake struck Kobe, Japan’s second
largest port, in January 1995, causing $110 billion in damage to a city
that handled 30 percent of the nation’s trade. In addition to killing
5,500 and leaving 300,000 homeless, the quake destroyed 75,000
buildings and damaged another 200,000. It took two years to rebuild.
The impact on the Japanese GDP, however, wasn’t all that big.
The hurricane’s damages, as we all know, were significant in
absolute terms—estimated at up to $200 billion. We’ve all seen
television footage of thousands of destroyed and damaged buildings. Up
close, it looks overwhelming. But it is important to bear in mind that
Katrina’s estimated physical losses amount to only a third of a
percentage point of national wealth.
Among the American economy’s strengths are its size, diversity,
interconnections and resiliency. I fully expect the economy to rebound
from this disaster—as it did after the Sept. 11, 2001, terrorist
attacks. And the Northridge, California, earthquake in 1994. And
Hurricane Andrew in Florida in 1992.
And he is not sure what to think about inflation:
is clear, however, that a period of price volatility cannot be avoided
for energy and other commodities processed, stored and transported
along the Gulf Coast and the mighty Mississippi. The headlines have
been full of news about gasoline climbing above $3 a gallon, although
crude oil prices have already receded from their peaks. The massive
effort to rebuild the Gulf Coast will create additional demand for
lumber, steel, cement and other building materials. With so many prices
in flux, our inflation measures will be tricky to read over the coming
I find this somewhat remarkable. Given
that he clearly sees rising prices, how exactly are inflation measures
tricky to read? Interestingly, Fisher also has a message (threat?) for
Congress and the President:
surrounds Katrina’s effects on economic growth and core inflation, one
thing is clear: Congress and the executive branch are acting swiftly to
provide emergency funding for the affected areas. So far, the federal
government has authorized more than $62 billion for recovery efforts. I
have asked my staff to carefully monitor this spending. Obviously, the
political authorities, not the Federal Reserve, have the power of the
purse. I pray they act wisely. With the nation’s already large fiscal
deficits, I personally believe it would be ill-advised for the Fed to
monetize any fiscal profligacy.
Fisher clearly does
not want the Fed to accommodate fiscal deficits – it is almost as if he
is saying that if the Fed continues to raise rates, Congress and the
President have only themselves to blame.
There are some other fun bits to Fisher’s speech, but I will leave
additional parsing to others. Here is my take on Fisher: He is a
dove, pure and simple. He would stop raising rates yesterday if he
could. But he recognizes that he is a maverick voice on the FOMC, and
consequently tries to stick to the party line, which would be, in my
opinion, to downplay the impact on economic activity and play up the
inflation story. But his heart just is not in it.
The other key insight into Fed policy comes from the Beige Book,
which last week reported that prior to Katrina, all districts except
Boston saw increased economic activity, tightening labor markets,
modest wage gains but rising benefit costs, and, possibly most
Higher energy costs were reported by
almost all Districts, and energy-intensive industries were able to pass
some of these costs on to consumers in the Atlanta, Boston, Cleveland,
Chicago, Kansas City, Minneapolis, Philadelphia, and San Francisco
Granted, all of this is pre-Katrina. But
I imagine that anecdotal evidence collected today would have the tone
of that in today’s Wall Street Journal article, “Manufacturers Gear Up After the Storm.” Notably:
But while rebuilding hurricane-ravaged regions will eventually mean
more orders, it's also bringing more immediate supply glitches and
rising prices, particularly for petroleum-based raw materials. Certain
manufacturers are building inventory of steel, plastic resins and
cardboard boxes and such stockpiling could eventually lead to even
higher prices in the near term. The result is an uneven picture, as
certain manufacturers gear up to produce more, while also facing
negative cost and supply-related fallout from the storm.
an accurate description of the Fed’s conundrum. While some demand
pressures fell (at least temporarily – energy prices are pulling back
from their highs) as a result of Katrina, others look poised to
strengthen, all in the background of higher prices from a shock to the
nation’s productive infrastructure. Sounds to me like the recipe for
Of course, there is time between now and next week for incoming data
to sway the Fed. But I suspect that data will have to be significantly
out of line with expectations to steer the Fed from its current
course. Of course, I have trouble calling a rate hike a sure thing –
simply too much uncertainty at this point. As I see it, the mostly
likely reason for a pause at this point is to take an opportunity to
wait for more data.
I think, however, that the Fed will find this a weak excuse to
pause. Fedspeak (at least 3 out of 4) so far has shown concern for
tight labor markets and rising energy costs – a signal that FOMC
members are looking to get ahead of price pressures. So considering
the way the Fed tends to look at the economy, and the possible
inflationary pressures resulting from Katrina, the Fed is mostly likely
poised to pull the trigger again next week, despite the devastation in